Potash - a battle for grey dust that has become gold dust

The market for a particularly lucrative gray dust has been thrust into the spotlight this summer with news of a $38.5bn (£25bn) hostile takeover bid from Australian mining giant BHP Billiton for Potash Corp of Saskatchewan in Canada a business coined by some as the “Saudi Arabia of Potash”!

BHP has already been active in acquiring businesses in the potash industry. In addition to existing projects owned by the business, in March 2010 it made a $320m acquisition of Canadian listed Athabasca Potash. But Potash Corp of Saskatchewan is a takeover target on an altogether different scale.

Potash is shorthand for potassium carbonate - a potassium compound often used in agriculture and industry. Potash is the third major plant and crop nutrient after nitrogen and phosphate and the vast majority of the annual global supply is used as a soil fertilizer.

It is a product with virtually no close substitute making the demand insensitive to the ruling market price - the price elasticity of demand for potash is very low and high prices make the product hugely profitable to supply - PotashCorp made net profits in the second quarter of 2010 of $472m. Potash itself has been trading at about $350 a tonne

Drivers of demand for potash

There are several factors coming together at the same time to explain a rising demand for fertiliser across the world.

Firstly, much of the world’s existing farmland is under-fertilised and the world’s demand for food is likely to grow strongly in the years ahead because of rising global population and the higher demand for meat especially in the developing world. Global population is expected to rise by more than 800 million in the next decade, the majority of which will be people in developing nations living in urban areas. Keep in mind that it takes about 8kgs of grain to produce a kilogramme of beef - little wonder that there will be increased demand for grains from livestock farmers.

The supply of arable land has come under pressure from urbanisation and a shift of farm land away from food production towards growing bio-fuels. So the long term importance of fertiliser in boosting agricultural productivity is set to rise and this has been a key factor driving the demand for and the price of potash ever higher.

Constrained supply and barriers to entry in the industry

On the supply side of the market - global potash supply is limited - only 12 countries around the world supply it with the majority of production flowing from Canada, Russia and Belarus. Canada and the former Soviet Union account for 80 per cent of reserves and two-thirds of production. And Potash Corp on its own is already responsible for more than 20 per cent of global production. All three countries set their supply prices using an industrial alliance - controlling exports and keeping prices relatively high.

Extending capacity in the potash industry is difficult - each potash mine takes at least seven years to build, compared to less than two for other types of fertiliser. One market analyst has been quoted as saying that “Potash has the highest barriers to entry and is found in the fewest countries”. The market is highly concentrated - it is effectively a duopoly.

In the case of Canada, the export cartel Canpotex is wholly owned by Canada’s three major producers. 70% of world supply comes from Canada and Belarus - both of whom operate export cartel arrangements. For the people of Saskatchewan, home to one-quarter of the world’s potash production, the health of the potash industry is of huge importance - the state authority took in Canadian $1.4 billion in potash royalties in 2008/09, or about one-tenth of its annual budget.

Will there be a move to freely moving market prices?

You won’t find a price chart in this article because supply contracts for potash deliveries aren’t listed on an international exchange. But if BHP Billiton is successful in acquiring Potash Corp - it may opt to move the potash market away from the duopolistic cartel that controls prices towards a market-based pricing system where the daily price for potash can fluctuate in spot trading. Whether this leads to higher prices in the medium term will depend on the balance between global supply and demand - and it is an uncertainty much in the minds of farmers around the world from China to India and from Australia to the UK.

For China in particular with a well-publicised aim of self-sufficiency in grain production – the need to import at least fifty per cent of its potash needs may prompt a counterbid to BHP Billiton - Sinochem, the chemicals group that also handles China’s potash imports is said to be watching this hostile takeover battle with special interest.

Paul Mason has this excellent report from BBC Newsnight